Six months is a long time,” sang The Smiths. Perhaps they were right: we are now six months into the new income drawdown regime. While the changes have been well received, advising in this area has not been an easy task because of unique market conditions.
The first issue is the government’s decision to cut the GAD limit from 120% to 100%, aiming to prevent people drawing down their pots too quickly and falling back on the state. The change has polarised the industry, with some industry figures lobbying the Treasury, saying it could not have come at a worse time. Clients coming up for drawdown reviews face a witch’s brew of issues hitting drawdown pots. Choppy investment markets have put a dent in many people’s pension pots. This, coupled with the decreased GAD limit means many retirees are facing a sizeable decrease in the income they can take from their pots.
However, there are others who say the higher GAD limit was unsustainable, particularly as people are living longer. However, no matter what side of the fence you are on, it is clear to see the change is having a negative impact on many people’s income.
A case study from AJ Bell explains how an average investor could see their retirement fund decrease. A 60-year-old man with a fund of £300,000, who went into drawdown on 1st December 2006, had a maximum annual income of £22,320. AJ Bell forecast that his annual income would grow to £25,200 on his review date in five years’ time, rising as he aged. But now the review has arrived, he will have only a maximum annual income of £15,432, a huge drop of over £9,000. This could be grossly out of step with his retirement aspirations and financial obligations.
But how did this shortfall happen? AJ Bell calculated the pot was struck by: falling gilt yields (38.24%); the 20% uplift removal (37.19%); plummeting investment markets (18.18%); and the Government’s GAD table update (6.38%).
Clients with a strong IFA relationship should be well aware that drawdown is an investment product that will go up and down to mirror the market. They should have been profiled to assess whether it would suit them best, as opposed to the guarantees of the annuity path. For AJ Bell’s marketing director Billy Mackay, the key challenge for advisers is: “People have to understand the nature of the risks they are exposing themselves to.”
But, with many becoming risk-averse following significant losses to their savings, advisers should be monitoring portfolios to establish whether clients are gaining the outcomes they hoped for and whether remaining in income drawdown continues to suit their risk profile.
Intelligent Pensions’ managing director Steve Patterson says: “A well-organised adviser will have the position by and large under control with a process that should lead to a successful outcome in all cases.” These successful outcomes should include helping clients wanting to come out of drawdown during a period of volatility.
In that case, how often should advisers see their drawdown clients? While it is compulsory for people to review their drawdown portfolio every three years, there are no guidelines for frequency of client contact. Many advisers advocate the benefits of regular reviews to ensure the client’s portfolio is in tune with their changing needs. For AXA’s head of pension development Mike Morrison, the need to see an IFA has increased, he hopes: “At least once a year, in volatile markets.”
But the IFA meeting can have other pitfalls, as the FSA has placed increasing scrutiny on drawdown advice. As Morrison says, the FSA “couldn’t comment on whether the advice was good or bad, because people’s records weren’t good enough”. Advisers have to ensure they document the advice process adequately. However, while the FSA is scrutinising drawdown advice at point of sale, there is also another issue that older clients could be “drifting into unsuitability” for drawdown following the removal of the Age 75 rule.
Quite simply, a number of people could remain in drawdown throughout their seventies, although other options could be more suitable. For instance, as the client ages, an enhanced annuity could become more appropriate due to the guarantees and the mortality cross subsidy granting a higher rate of income. Patterson explains that previously there was “a regulatory event horizon, because advice had to be given, to go into ASP or convert to an annuity”.
However, now there are no guidelines on how clients should fund their latter years. With this in mind, advisers should be monitoring older clients more closely and planning exit strategies accordingly. Mackay says: “At some point, people should be thinking about buying an annuity. Many clients in drawdown appreciate having an annuity available as an option. They like the control of funds they have actively invested and taking funds from it. However, while it’s an option, I don’t think it’s a given, going down the annuity route.”
However, annuities are not without their problems, as rates have continued to fall. Ultimately, advisers have to decide whether this route is best for their client: annuity purchase is a question of timing. When looking at alternative options to increase income, the adviser should review the drawdown contract carefully. The AJ Bell case study highlights a pressing problem. As the member’s annual review will not happen for another three years they could find themselves locked into a low GAD rate (December’s GAD rate was historically low at 2.5%). A potential route is a provider switch.
Morrison says: “Some providers offer a member nominated annual review, so you can re-calculate your income each year. One thing [for clients] to talk to [their] adviser about is whether it is worth moving the contract to one of those providers who offer a member nominated annual review.” If next year, gilt yields have gone up and investment markets have stabilised, that client could carry out the review and fix a higher level of income.
While members of capped drawdown have found themselves hamstrung by the reduction in GAD from 120% to 100%, the new rules also brought in flexible drawdown, which enables individuals to draw unlimited funds, subject to meeting a minimum income requirement. So, are advisers seeing more clients turn to flexible drawdown at a time where gaining access to more funds could be a lifeline, not a privilege?
According to IFAs, this is not the case. Although there was keen interest when the changes were unveiled, it has not manifested into a desirable take-up. The Retirement Adviser’s divisional director Nick Flynn says his clients “have put themselves in the situation where they can flip the switch [between capped and flexible drawdown] whenever they want and draw as much income as they see fit. But none of them are doing it. Everyone wants to take advantage of it, but no one’s ready to take advantage of it.”
While people want to make sure they can enter into flexible drawdown if and when they need it, (for example, to help children onto the property ladder), they do not want to raid their funds while the value is depressed. Hornbuckle Mitchell’s sales and marketing director Mary Stewart has seen many in the “planning phase” as they are making the most of carry forward rules for next year.
However, she believes that flexible drawdown could take off in a meaningful way as baby boomers retire as many will have amassed sizeable final salary pensions. Also a market recovery could mean current cautious investors could decide to make the leap into flexible drawdown.
Alongside the potential financial rewards of good market timing or a product switch, advisers should review providers in the light of a recent warning from Hargreaves Lansdown. Some providers have not updated their systems in line with the new rules, automatically forcing people to annuitise at 75.
Pension investment manager Laith Khalaf also cautioned: “It’s important for each individual to look at the service, cost and functionality of their plan” to assess whether it is fit for purpose in light of the legislative and market changes. Advisers should ensure their clients are not hit by these hidden risks and put steps in place to ensure they can transfer provider in a cost-effective method.
A diverse porfolio
But, what else should be in place to mitigate huge losses to retirement incomes? For some advisers, a pension alone is simply not enough. Advisers should ensure clients have a diverse portfolio to secure the best outcomes in retirement. Morrison says: “If a client has savings and other investments it might be possible to take income from them and build into their overall income requirements.”
While the changes to the drawdown regime have given much extra flexibility to clients it is clear this levels extra responsibility on advisers. However, by keeping a close eye on the investment markets and taking well-timed decisions on income levels and risk tolerance advisers can really help their clients to weather the current conditions.